Doing Business in China – recent developments

1. Doing Business in China – recent developments Vivienne Bath Senior Lecturer and Director of the Centre for Asian and Pacific Law

2. Legislative change • Proliferation of new legislation post-WTO accession • Significant new legislative developments in the corporate and business sector over the last year • Themes: modernisation of corporate legislation; introduction of bankruptcy regime; possible step back from totally open-door policy for foreign investment

3. Legislation • Changes to Company Law and Securities Law 2005 • New Bankruptcy Law 2006 • Changes to mergers and acquisitions regime 2006 • Draft anti-monopoly law – 2007? • Amendments to Criminal Law 2006 • Proposed changes to Trademark Law, Patent Law, draft Property Law, draft Labour Contract Law

4. Company Law • First effective 1 July, 1994 • Most recently amended 2005, effective 1 January 2006 • Deals with • Limited liability companies • Joint stock companies (companies limited by shares) • Foreign investment enterprises, except to extent FIE laws otherwise provide

5. Limited liability companies – changes to capitalisation • Registered capital, not shares • Minimum amount RMB30,000 ($5,000) • May be paid over 2 years (5 for an investment company) • Must pay in 20% or statutory minimum amount as initial contribution • May be paid in cash (at least 30%), in kind, in IPR, land use rights or other non-monetary contributions • One shareholder companies now possible • Flexibility to nominate legal representative

6. Implications for Foreign Investors • Limited liability companies for Chinese investors only • Now referred to as “foreign invested companies” (FICs), with numerous sub-classifications • Single shareholder rules apply to WFOEs with one shareholder • Provisions relating to capital contributions apply to FICs

7. Implications for Foreign Investors • Previous limit on investing more than 50% of assets removed • Requirement for FICs to go through special procedure to invest in Chinese companies also removed

8. Shareholder rights • Duties of shareholders (Art 20) • Controlling shareholder and officers (Art 21) • Resolution of shareholders or directors that violates a law or administrative regulation – null and void (Art 22) • Resolution at meeting improperly convened under law, regulation or AA – shareholder may apply to court to revoke it (Art 22)

9. Duties of officers • Art 147: restrictions on acting as a director, supervisor or senior manager • Art 148: duty of fidelity and diligence to company • Art 149: acts by director or senior manager inconsistent with the obligation of fidelity – income belongs to the company

10. Duties of officers • Art 150 – obligation of Ds, Ss and senior managers to compensate company for loss to the company due to breach of laws, regulations or AA in carrying out duties • Art 151 – right of shareholders to require D, S or senior manager to attend meeting and answer questions • Art 152 – right of shareholders to take action in case of Art 150 infringement • Art 153 – right of shareholders to bring lawsuit for action infringing shareholders’ interests

11. Securities Law • Establishes sponsor system for public offerings • Requires deposit of investor funds into separate bank accounts • Contemplates establishment of State fund to protect investors and allow for compensation • Increased penalties for illegal acts – fraud, insider trading

12. Securities Market • Gradual sell-off of State shares • Merger of A and B share markets? • QFIIs and their role in the A share market • Strategic investments in A shares • Expansion of Chinese companies and interests outside China

13. Bankruptcy Law - Issues • What should the law cover? • Role of government – court run process • Financial institutions • Role of the administrator • Rehabilitation • Priorities in distribution of assets • Cross-border bankruptcies

14. Enterprise Bankruptcy Law • Comes into effect 1 June 2007 • Applies to state-owned enterprises, private companies, financial institutions and FIEs • Special section on financial institutions • Law applicable “by reference” to organisations other than enterprise legal persons

15. Grounds for Bankruptcy • Entity is unable to pay debts when due and does not have sufficient assets to pay debts or clearly demonstrates that it lacks the ability to meet payments

16. Parties • Debtor may file a petition with People’s Court for rehabilitation, composition or bankruptcy liquidation • Creditor may file if debtor becomes insolvent • Person with legal responsibility for liquidating an enterprise legal person which cannot pay its debts must file

17. Bankruptcy Law • Options: declare bankruptcy; undergo reorganisation (rehabilitation); reach settlement with creditors (composition) • Participation of courts required • Position of secured creditors preserved • Priority of payments: liquidation debts, payment to employees (wages and social security benefits); social insurance and taxes; general creditors

18. Bankruptcy Law • Liquidators/administrators to be appointed by court: government officials; lawyers, accountants and insolvency specialists – may be individual or a firm • Creditors’ meeting (creditors who have submitted claims) – verifies claims; supervises administrator; appoints members of creditors’ committee; adopt scheme for realization and distribution of bankruptcy property

19. Bankruptcy Law • Creditors’ committee: supervises management of property; distribution; convenes creditors’ meetings • Penalties on senior management for mismanagement • ‘Policy bankruptcies” for approximately 2000 failing SOEs possible in next year

20. Rehabilitation • Debtor (or 10% of shareholders) or creditor may file with court a request for rehabilitation • Court may order rehabilitation • During rehabilitation period, debtor manages property under supervision of administrator or administrator manages property • Exercise of security prohibited; no distribution of profits; no assignment of equity

21. Rehabilitation • Court can order termination and bankruptcy if continued deterioration; fraud; debtor stops administrator from acting • Rehabilitation plan must be approved by creditors, employees, etc. • At conclusion, debtor no liability for debts discharged under the rehabilitation plan

22. Composition • Debtor may file petition for composition at any time, including after acceptance of bankruptcy petition • Must submit composition agreement • Must be approved by half of creditors with not less than 2/3rds of claims • No effect on secured creditors • If composition agreement not satisfied, court will order bankruptcy

23. Cross-border bankruptcy provisions • Judgment of People’s Court has effect in relation to assets of debtor outside China • Judgment of foreign court affecting assets inside China recognised and enforced pursuant to treaties or principles of reciprocity • If no basic principles of PRC law, national sovereignty, security, interests of general public or creditors within PRC undermined

24. Draft Anti-monopoly Law • Applies to: monopolistic behaviour within China; monopolistic behaviour outside China that has “eliminative or restrictive” effects on competition in the Chinese domestic market • Prohibits monopoly agreements • Prohibits resale price fixing

25. Draft Anti-monopoly Law • Prohibits collusion on bids • Prohibited agreements void ab initio • Allows some defences to monopoly agreements and resale price fixing

26. Draft Anti-monopoly Law • Prohibits abuse of dominant market position to eliminate or restrict competition • Abuse includes: monopoly pricing; predatory pricing; refusing to trade; mandatory or exclusive trading; tying; differentiated treatment without valid reasons.

27. Draft Anti-monopoly Law • Ability of Anti-monopoly Authority to prohibit or impose conditions on a “concentration” (merger or acquisition) if may have effect of excluding competition • Notification requirement if • All parties have worldwide turnover exceeding RMB12billion • One party has China turnover exceeding RMB800million

28. Draft Anti-Monopoly Law • Prohibits abuse of administrative powers by administrative organs or public organizations to • Require enterprises and individuals to deal in, or purchase or use products of designated entities • Hinder free circulation and adequate competition in commodities • Restrict participation in bidding

29. Draft Anti-monopoly Law • Restrict investment or establishment of branches • Compel undertaking to engage in monopolistic conduct • Create rules with content which eliminates or restricts competition

30. Draft Anti-monopoly Law • Anti-monopoly Commission under State Council – policy, supervision of enforcement authority and harmonisation of handling of major cases • Anti-monopoly Law Enforcement Authority under State Council – guidelines; investigations; mergers and concentrations • Protection of whistle-blowers - confidentiality

31. Draft Anti-monopoly Law • Liabilities • Fines (1%-10% of previous year’s turnover or up to RMB2million if agreement not implemented) • Confiscation of illegal gains • Order to cease offending act • Order to cease concentration or sell assets • Criminal liability if relevant • Exceptions: law does not apply to agricultural producers and farmers’ associations

32. Draft Anti-monopoly Law • Issues and complaints • Unclear definitions of “dominance”, “market share” and “unfair prices” • Automatic assumption of dominance if company holds a set share • Local nexus for “concentrations” (RMB800million) too low (international is RMB12billion) • Fines on turnover do not specify whether turnover is Chinese or international • Not clear who would investigate or punish misbehaviour by administrative bodies • Not clear what power local investigating bodies will have or whether can institute actions on their own.

33. Mergers and Acquisitions • M&A with domestic enterprises Provisions on the Acquisition of Domestic Enterprises by Foreign Investors effective 8 September 2006 • Replaces 2003 Tentative Provisions • Deals with foreign investor doing M&A deal with existing Chinese (not state-owned company) • Emphasis on control over acquisitions by Chinese-owned overseas enterprises

34. Mergers and Acquisitions • M&A means: • Purchase of an equity interest in a domestic enterprise (not an FIE) • Subscribing to the increased registered capital of a domestic enterprise • Establishing an FIE which will acquire the assets of a domestic enterprise and use assets for operations • Purchasing assets of a domestic enterprise and using them as investment to establish an FIE to operate the assets

35. Mergers and Acquisitions • Resulting entity must be an FIE • Entitled to FIE benefits only if foreign investor holds 25% or more • If foreign entity is Chinese owned, only entitled to FIE benefits if foreign entity contributes an extra amount equal to 25% of more of capital • Provision for independent appraisal – particularly if parties affiliated • MOFCOM review in certain circumstances

36. Mergers and Acquisitions • Necessary to provide employee allocation plan to make clear what will happen to employees • Equity purchase agreement/asset purchase agreement to be governed by Chinese law • Provisions provide for share swaps • Special provisions on Chinese-owned special purpose companies

37. Mergers and Acquisitions • Must submit report to MOFCOM if project meets conditions relating to annual revenue (where Chinese party revenue exceeds RMB1.5 billion), has 10 enterprises in China, one party has market share in China of more than 20% or transaction would enable relevant party to hold market share in China of 25% • May in any event be required to submit a report and MOFCOM or industry associations and domestic competitions can request hearing on request of domestic competitor if MOFCOM believes project involves significant market shares or important elements affecting market competition • Requirements also in relation to offshore mergers

38. Takeover Provisions • Measures for the Administration of the Acquisition of Listed Companies • Allow for partial bids • Government approval required for takeovers by foreigners, and where state industrial policies, state-owned shares etc involved • Limits on purchasers • CSRC to set up a takeover committee to review proposed takeovers • Disclosure requirements (from 5% holding)

39. Draft Labour Contract Law • Requires severance pay when contracts not renewed – not just on termination • One-time compensation equal to annual salary to enforce non-competition agreement (for maximum of 2 years) • Increased employee participation in drafting of employers rules and regulations affecting employees • Increases involvement of unions – must be advised on termination prior to event, regardless of cause • Requirement of collective contracts

40. Summary • Increasingly willingness of Chinese legislators to legislate with extraterritorial effect • Proliferation of legislation – difficult to absorb; difficult to enforce • Increase in number of regulatory bodies? (e.g.., Anti-Monopoly?) • Concern about issues arising from modernisation – protection of labour; protection of state assets; foreign domination of Chinese markets • Backlash against foreign investment?